There are two major types of corrections:
1. A normal pullback within a bull market – this is a garden-variety 5-8% pullback above a rising 200-day moving average. Momentum stocks with the highest relative strength during the correction are likely to significantly outperform during a recovery.
2. Deeper 15% to 20% correction in a major index – this one characterizes with periods of massive forced liquidation when people and institutions sell not because they want to, but because they have to. These type of corrections often start below a flat or declining 200-day moving averages of a major index. Some of these corrections turn into bear markets, which last more than a year. The best performers during a recovery are usually the ones that were hit the hardest during the correction – the ones that are down >80% from their 52-week highs, the ones that were essentially priced for a bankruptcy, but managed to survive.
Based on the current price action, I believe we are in the first kind of correction. Act accordingly.
